True Cost Of Credit

This morning, via the Consumerist, I found this site called, “The True Cost Of Credit.”

You Can’t Judge A Story By Its Title

With a title like that, I expected many things. Perhaps it was a detailing of the cost of credit cards to American consumers in interest and fees. Or, maybe it is the cost to the economy when people default on their credit cards. It turns out that the article is really the “true cost of credit” to businesses that accept credit cards.

The article has a tool that allows you to put in a portion of your credit card number, and then shows you the merchant fees assessed to the business making the sales. It turns out that merchant fees include both a fixed amount per transaction, as well as a percentage of the total sale price. This produces the odd effect of merchant fees consisting of a larger percentage of the cost for lesser priced items, and a smaller percentage of the cost for higher priced items. Overall, they estimate that merchant fees add up to a total of 50 billion dollars a year.

So What?

Credit cards are not a charitable organization, they are a business that makes a profit. This profit comes simultaneously from two sources, the merchants and the card holders. This site shows how the merchants are being charged. What do they get in return? They get several benefits from accepting credit cards. Obviously, it is a preferred method of payment for more customers, so they get increased sales. They also have their transactions conducted quickly. Consider that next time you are in line behind someone fishing through their purse for enough pennies to complete a sale, or when the cashier runs out of a particular denomination of currency. The merchants are also protected against fraud, just like we consumers are when we use charge cards. They do not have to worry if your money is counterfeit, if their employee counts it correctly, or even if the customer never pays their bill. In all circumstances short of a charge back, when the card issuer authorizes the transaction, the merchant is guaranteed payment.

Where Do These Fees Go?

A lot of it is profit for the card companies. If you play the reward card game successfully, some of that profit goes back to you. Take my American Express card for example. According to this site, Amex will charge the merchant 3.5% plus about 25 cents per transaction. In return, I am getting a Starpoint, a Delta SkyMile, a Membership Rewards Point, or some amount of cash back. With my Business Platinum Amex, I get 5% back on gas, wireless bills, and office supplies. In theory, Amex is actually loosing money on each of these transaction. In reality, I imagine they make it up on sales of other goods, and possible some other kickback from the merchants. If they do not, I am sure they turn a profit off of the interest and fees paid by others.

Are They Excessive?

Perhaps, however the merchants are free not to agree to take these cards, as plenty of business chose not accept American Express, Discover, or sometimes all credit cards. A bigger question would be: Is their anti-competitive behavior going on between the limited number of major card companies, Amex, Visa, Mastercard? I honestly couldn’t answer that question, however, if I was a merchant, I would probably resent 3.5% of my sales disappearing.

For better or for worse, I am not a merchant. While I know that Amex has the highest merchant fees, I also know that this likely explains why they tend to pay out the highest rewards. I didn’t invent the rules, but I am happy to play along and get points and miles often worth 5% of each transaction.

The key is that by always paying on time and in full, I become a “freeloader”. I earn rewards based on both the merchant fees paid by the business I spend money with, and the interest and fees paid by others. Beyond that, I always keep in mind the numerous non-reward benefits the credit card offers me over cash. These perks include, charge backs, fraud protection, and the ease and safety of handling as compared to cash. With up to 45 days worth of interest free “float” between my first charge of the month and my payment being due, I actually earn interest using my credit card that I would not have earned with cash.

Just like banks operate in the margin between the interest rates given to depositors and those charged to borrowers, credit card companies operate on a margin. They offer benefits to both merchants and consumers, while profiting from each as well. The rewards you can earn are merely a slice of that margin that you earn by avoiding fees and interest.

Now that you know how the process works, you will now be able to better understand how to play the game, and win.